China Trends #4 - Impact of the Trade War on the Chinese Economy

Professor Zhong Maochu of the Institute of Economics at Nankai University, is similarly confident in China’s ability to cope with escalating trade frictions with the United States. He argues that the high level of economic interdependence between the two economies make full decoupling (脱钩) or the comprehensive suppression of the Chinese economy prohibitively difficult.² At the same time, he expresses confidence that the reform of China's economic system gives it the ability to digest transaction costs caused by trade frictions. Zhong also extols the size and resilience of the Chinese economy, its well-developed infrastructure system, and the virtues of China’s consumer-facing technology industries. He also heaps praise on China's experienced macroeconomic decision-makers who helped formulate a "rational and effective response strategy" to cope with the 2008 Global Financial Crisis.

Zhong, like Song, frames his narrative around American decline and portrays the trade war as an attempt by the U.S. to blame China for its own economic mismanagement. He identified the root causes of America’s economic problems in the hollowing out of manufacturing, heavy debt burdens, excessive consumption, and trade deficit-are due to its long-term accumulation of the global currency status of the U.S. dollar. While it is true that China did not cause these problems, the author does not acknowledge that China’s own export-oriented growth model was made possible by many of these policies. The role of American FDI in China does not feature in his narrative. Instead, Zhong argues that the United States cannot afford to exclude China from the "full industrial chain" (全产业链) because its own economic system cannot bear its heavy price, and can only target China’s "shortcomings" (短板) with trade barriers. While he does not provide specific examples of these "shortcomings", he is most likely referring to Chinese technology companies placed on the U.S. entities list. Zhong argues that the most critical path to "make up for shortcomings" is to replace the industries affected by economic and trade frictions by developing new industries.³This somewhat controversial recommendation amounts to fighting decoupling with decoupling and an implicit endorsement of the indigenous innovation industrial policies that led many U.S. multinationals to endorse the Trump administration’s trade war.

He writes that the disruption of manufacturing by technological advances has driven the field of scientific and technological innovation into an arena of strategic competition between the two countries and acts as an essential motivation behind the trade war. Unlike Zhong, Chen urges that China should strive to "build an innovative country" (建立创新型国家) and become a "major technological power" (科技强国) by adhering to WTO rules and by taking the initiative to implement reform and opening up.

Chen criticizes the United States' practice of unilateralism and protectionism as going against the tide of globalization. But his policy recommendations to create an "independent innovation capability system" (自主创新能力体系) leave more room for foreign participation. He urges China to expand FDI and cultivate multinational enterprises with global innovation capabilities. He advocates for strengthening international technology exchanges and cooperation and for building world-class innovation platforms based on domestic universities and research institutions. However, he does not sideline government involvement in the economy to promote innovation. Instead, he calls for the use of "reasonable industrial policies" (合理的产业政策) to guide domestic capital into the high-end industrial chain of global emerging industries and become multinational enterprises with global innovation capabilities. He argues that the government must play a role in basic research, in licensing technology, in encouraging enterprises to seize opportunities in emerging industries, and in investing in higher education. By strengthening investment and policy guidance, Chen argues, China can build a world-class university and research institution, rely on it to conduct independent research and development of technology, and cultivate innovative talents and high-quality laborers. According to this view, the government plays a mediating role between social capital and corporate capital to encourage innovation.

Other recent data show that China is leaning more heavily on the state sector for fixed asset investment (which is also slowing dramatically and trade, consumption, and investment are all down). At the same time, domestic pressure is building for the government to ease monetary policy or ramp up government spending to stimulate growth, which could exacerbate China’s debt hangover. Beijing is trying to make up for these structural disadvantages with political resolve and has thus curtailed the scope of permissible public discourse accordingly.

Above all, the trade war is a strategic game. If the U.S. agrees to lift tariffs, then China does not have to face these difficult policy trade-offs; but the U.S. would have no reason to lift tariffs if it believes that China will capitulate. Thus, as this war of attrition drags on past 500 days, both economies are hurt but have the incentive to hold out until the other side gives in. This may be one reason that scholars publishing in less visible outlets behind academic journal paywalls have adopted a much more conciliatory tone. For example, Professor Liu Feng of the Institute of International Relations at Tsinghua University⁵ has recently called for scholars and policy makers in the U.S. and China to jointly explore how to effectively manage strategic competition and avoid long-term systematic confrontations. It is also worth noting that Song’s People’s Daily op-ed is framed against the view that "China should not fight back" and "make every effort to meet U.S. demands". While he denounces this view as "obviously wrong, naive, and very harmful", this framing acknowledges the debate exists and is worthy of rebuttal. The full diversity of Chinese academic assessments of the trade war’s impact are thus difficult to measure with state-sanctioned sources and not adequately represented by the three authors profiled in this article.

¹Song Guoyoun, "To End the War, China Should Fight, Must Dare to Fight, And Can Fight Well", People’s Daily 人民日报, 29 August 2019, http://opinion.people.com.cn/GB/n1/2019/0829/ c1003-31323709.html

²"Zhong Maochu, "China’s Economy Is Fully Capable of Coping with Escalating Sino-US Economic and Trade Frictions", Specials 特别策划, 14 June 2019.

³Ibid.

⁴Ibid.

⁵Liu Feng, "Limits and Management of Sino-US Strategic Competition", Contemporary International Relations 现代 国际关系, 2019, http://mall.cnki.net/magazine/Article/ XDGG201910003.htm